Gregg Michael Kellett v. Comm’r: A Case in Biotechnology

Kellett v. Comm’r, T.C. Memo 2022-62 | June 14, 2022 | Greaves, J. | Dkt. No. 21518-18


The IRS disallowed a $25,992 business expense deduction resulting in a corresponding deficiency of $6,475 in 2015. 

Kellett ran a business information website which started upon the website’s opening in September 2015. This website compiled demographic, social, and economic data and attempted to make a user-friendly version of Google or Yahoo Finance. The website was developed with engineers who built the desired features and functionality. On a timely filed 1040, the taxpayer claimed expense deductions for these engineers as well as a marketing strategist, cell and internet service cost from his home, and some miscellaneous expenses. The IRS denied all deductions on the grounds that the business had not started.

The Tax Court set out to determine:

  • When does a business start for purposes of § 195?
  • Can a taxpayer expense the costs of developing software under § 174 before the business technically begins, or is he solely relegated to relief under § 195?
  • Can a taxpayer use Rev. Proc. 2000-50 to deduct the costs of developing a website?

Key Points of Law:

  • 195 Start-up Expenditures: § 195(a) disallows deductions for start-up costs except for provided in this section. Therefore, under § 195(b), a taxpayer generally can deduct up to $5,000 of start-up expenditures. However, if the costs are in excess of $50,000, then the amount is phased out dollar for dollar until $55,000. § 195(b)(1)(A)(i)-(ii). Any amount phased out, or in the event the costs exceed $55,000, the taxpayer must capitalize the capital outlay and then amortize it ratably over 15 years. § 195(b)(1)(B).
  • 174 Research and Development: Taxpayers are granted relief from the harsh capitalization standards for start-up costs under § 174, but it applies only in limited circumstances. However, the general rule is that taxpayers may treat R&D connected with their trade or business as expenses not chargeable to the capital account. § 174(a)(1). § 195(c)(1) excludes from the definition of start-up expenditures any amount which a deduction is allowable under § 174.

The Court’s Decision And Learnings:

The court determined the business began in September of 2015 because that is when it began providing the services for which it was organized. Any expenses incurred before this date must be taken under § 195 and any expenses after this date are taken under § 162.

Further review brought the following decision: the taxpayer is disallowed from taking a § 174 deduction (i.e. R&D Tax Credit) since he merely adapted a widely used software rather than developing it from whole cloth.

This case highlights the importance of understanding the difference between development and experimental development. While website or software development may seem as though it is inherently R&D, developers must carefully consider if their product is novel and faces technical uncertainties. Modification of existing software rarely has significant enough technical uncertainty or experimental development work to pass the IRS’s four part test.

Click here to read the full case.

Are you conducting research and development activities? Did you know your development work could be eligible for the R&D Tax Credit and you can receive up to 14% back on your expenses? Even if your development isn’t successful your work may still qualify for R&D credits (i.e. you don’t need to have a patent to qualify). To find out more, please contact a Swanson Reed R&D Specialist today or check out our free online eligibility test.

Who We Are:

Swanson Reed is one of the U.S.’ largest Specialist R&D tax advisory firms. We manage all facets of the R&D tax credit program, from claim preparation and audit compliance to claim disputes.

Swanson Reed regularly hosts free webinars and provides free IRS CE and CPE credits for CPAs. For more information please visit us at or contact your usual Swanson Reed representative.

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